Trump's Individual Income Tax Reforms Could Fail Most Americans

It may be hard to believe, but in less than two weeks the unlikeliest of candidates when campaigning began, Donald Trump, will be sworn in as the 45th President of the United States.

Trump has a big agenda on his plate, and the fact that both houses of Congress remain controlled by Republican majorities lends credence to the belief that we could see a number of reforms take shape in the months and years to come. As outlined in his 100-day plan, Trump wants to repeal and replace the Affordable Care Act, implement a $1 trillion decade-long plan to rebuild America's aging infrastructure, and, of course, completely reform the U.S. corporate and individual income tax code.

The most immediate and likely impact Trump could have on the American worker is through individual income tax reforms. Trump's proposed individual income tax changes, which were revised in September, would work in two ways.

First, we'd see a complete overhaul and simplification of the U.S. tax brackets. Currently, taxpayers fall into one of seven ordinary income tax tiers, ranging from a low marginal tax rate of 10% to a high of 39.6%, as you can see below in the 2017 tax schedule.

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Data source: IRS. Table by author.

Trump's tax bracket proposal is considerably simpler. As you'll observe below, Trump is calling for just three tax tiers at 12%, 25%, and 33%, while long-term capital gains taxes would remain unchanged at a peak of 20%. If this plan looks somewhat familiar, it's because the 12%/25%/33% three-bracket individual income tax code was proposed by House Republicans last year. Trump's willingness to adopt the House Republicans' individual income tax reform proposal could be an indication of compromise in order to get legislation passed quickly once he's in office.

Data source: Donald Trump campaign website. Table by author.

The second component to Trump's individual income tax reforms involves refining the way deductions and exemptions are taken. And by "refining," I mean simplifying and eliminating the complexity of the individual tax code.

Trump would eliminate all forms of itemized deductions, with the exception of the mortgage interest deduction and charitable giving. Meanwhile, the new tax code would boost the value of the standard deduction for all Americans to $15,000 for individuals and $30,000 for couples, which is more than double the current standard deduction. Lastly, Trump's individual income tax plan would strike a number of taxes from the record, including the estate tax, net investment income tax, and Alternative Minimum Tax.

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Trump's assertion during his campaign was that his tax plan would put money back into the pockets of every American. And since we're a consumption-driven nation, putting more money into the pockets of working Americans could lead to faster GDP growth. An analysis from the Tax Foundation suggests that his individual reforms will result in a dynamic increase in GDP of 2.4% over the next decade.

But what if Trump's thesis doesn't hold water?

Image source: Getty Images.

Trump's individual tax reforms could fail most Americans

Despite Trump's prediction that his tax reforms will be great for America, there are two clear-cut deficiencies in his plan that could suggest otherwise.

Arguably the biggest issue with Trump's individual income tax reforms is the real possibility that it could worsen the income inequality problem in America. According to the nonpartisan Urban-Brookings Tax Policy Center, the revised Trump tax cut proposal gives 47% of the tax breaks to the top 1%.

Income inequality is often associated with slower growth potential, since lower-income individuals have fewer pathways to improve their socioeconomic status. For instance, it's more difficult for people with low income to get a college degree or skill that'll increase their chances of securing a well-paying job. It can also impact their health, with well-to-do persons often living longer since they have the income needed to pay for preventative medical care, medicine, and procedures. Nothing in Trump's individual income tax proposal suggests this is going to change or improve in the years to come.

The other problem with Trump's individual income tax reforms is that millions of lower- and middle-income Americans would actually see their taxes increase! According to the Tax Policy Center, about 8 million families would wind up paying higher taxes under Trump than they are now. In particular, Trump's tax reforms would hurt single-parent households and large families with three or more children. Currently, itemized deductions provide a bigger benefit to these households (e.g., a single parent being able to claim head of household), but the elimination of the head-of-household filing status and nearly all itemized deductions in favor of a larger standard deduction means these families, mostly lower- and middle-income, will owe more.

Image source: Getty Images.

An argument could also be made that Trump's individual income tax reforms could exacerbate an already growing national debt. A static analysis (i.e., not modeling out the positive and negative economic implications of Trump's proposals) by the Tax Foundation estimates that Trump's individual tax reforms will lead to a nearly $2.2 trillion reduction in federal revenue over the next 10 years. Meanwhile, the national debt is expected to increase. This means more money the federal government has to set aside to service the interest on that debt, and less money for education, infrastructure, defense, and other possible avenues to growth.

Obviously, no one knows with any certainty whether Trump's proposed individual income tax reforms are going to be a positive or negative for the U.S. economy. Only time is going to give us that answer. However, based on a number of analyses of Trump's tax plan, it may not have anywhere near its desired effect.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has adisclosure policy.